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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

(Mark One)

x                QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2014

OR

o                   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from           to           

Commission file number 1-10670

HANGER, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (512) 777-3800

Former name, former address and former fiscal year, if changed since last report.

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.) Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one).

Indicate by check mark whether the registrant is a shell company as defined in Rule 12b-2 of the Exchange Act. Yes o No x

As of August 1, 2014 35,290,946 shares of common stock, $.01 par value per share, were outstanding.

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HANGER, INC.

INDEX

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HANGER, INC.

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

(Unaudited)

The accompanying notes are an integral part of the consolidated financial statements.

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HANGER, INC.

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

(Unaudited)

The accompanying notes are an integral part of the consolidated financial statements.

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HANGER, INC.

CONSOLIDATED STATEMENTS OF INCOME

AND COMPREHENSIVE INCOME

For the Three and Six Months Ended June 30,

(Dollars in thousands, except share and per share amounts)

(Unaudited)

The accompanying notes are an integral part of the consolidated financial statements.

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HANGER, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Six Months Ended June 30,

(Dollars in thousands)

(Unaudited)

SUPPLEMENTAL CASH FLOW FINANCIAL INFORMATION:

The accompanying notes are an integral part of the consolidated financial statements.

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HANGER, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE A — BASIS OF PRESENTATION

The accompanying unaudited interim consolidated financial statements of Hanger, Inc. (the “Company”) have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of regulation S-X, and, therefore, do not include all of the information and footnotes required by U.S. GAAP for complete financial statements.  These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, previously filed with the Securities and Exchange Commission (“SEC”).

In the opinion of the Company’s management, the information contained herein reflects all adjustments necessary for a fair statement of the Company’s results of operations, financial position and cash flows. All such adjustments are of a normal, recurring nature.  The results of operations for the interim period are not necessarily indicative, if annualized, of those to be expected for the full year.

A detailed description of the Company’s significant accounting policies and management judgments is located in the audited consolidated financial statements for the year ended December, 2013, included in the Company’s Form 10-K filed with the SEC.

In the second quarter and first six months of 2014, the Company recorded certain adjustments that relate to prior periods totaling $1.9 million and $2.4 million, respectively.  The most significant adjustment relates to the recording of depreciation expense of $1.4 million in the second quarter of 2014 of equipment that should have been fully depreciated in prior years.  The Company recorded these amounts in the second quarter and first six months of 2014 as the Company believes the adjustments are immaterial to both current and prior periods.

Revision of Previously Reported Consolidated Financial Information

During the third quarter 2013, the Company corrected an error in the classification of certain components of bad debt expense. Hanger previously classified the reserves related to the write-off of older accounts receivable balances due from commercial and government payors as bad debt expense, which was reported as Other Operating Expense in its financial statements, instead of as a reduction of sales. Management has assessed the materiality of the classification error on previously reported periods and concluded the impact was not material to any of the prior annual or quarterly consolidated financial statements. The reclassification error had no impact on previously reported net income, balance sheet totals or the operating cash flows for any of the periods. The impact of the reclassification lowers sales and reduces Other Operating Expenses by equal and offsetting amounts in the Consolidated Statements of Income and Comprehensive Income and the Provision for doubtful accounts and Change in accounts receivable by equal and offsetting amounts in the Consolidated Statements of Cash Flows. Further, the Company has historically included the reserve for contra revenue in its presentation of the Allowance for doubtful accounts on the Consolidated Balance Sheets and the net change in the reserve for contra revenue in the Provision for doubtful accounts on the Consolidated Statements of Cash Flows and the Schedule II Valuation and Qualifying Accounts included in the Company’s Annual Report on Form 10-K. The Company has revised that presentation for all periods to only include the reserve for doubtful accounts and the related activity in the reserve for doubtful accounts in those respective balances.

Recent Accounting Pronouncements

In July 2013, the FASB issued ASU 2013-11, “Income Taxes” that requires unrecognized tax benefits be classified as an offset to deferred tax assets to the extent of any net operating loss carryforwards, similar tax loss carryforwards, or tax credit carryforwards available at the reporting date in the applicable tax jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position. An exception would apply if the tax law of the tax jurisdiction does not require the Company to use, and it does not intend to use, the deferred tax asset for such purpose. This guidance is effective for reporting periods beginning after December 15, 2013. The Company adopted this guidance and its implementation did not have a material impact on the Company’s Condensed Consolidated Financial Statements.

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers”, which clarifies existing accounting literature relating to how and when a company recognizes revenue. Under ASU 2014-09, a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods and services. This guidance is effective for reporting periods beginning after December 15, 2016. The Company is in the process of determining what impact, if any, the adoption of this ASU will have on its financial position, results of operations and cash flows.

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NOTE B — FAIR VALUE MEASUREMENTS

Assets measured at fair value on a recurring basis as of June 30, 2014 and December 31, 2013, are $2.6 million and $7.7 million, respectively, and are composed of cash equivalent money market investments. The money market investments are based on Level 1 observable market prices and are equivalent to one dollar. The carrying value of the Company’s short-term financial instruments, such as receivables and payables, approximate their fair values based on the short-term maturities of these instruments. During the second quarter of 2013, the Company refinanced its credit facilities by replacing its $300.0 million Term Loan and $100.0 million Revolving Credit Facility with a $225.0 million Term Loan Facility and a $200.0 million Revolving Credit Facility. See Note H for further information.

NOTE C — ACCOUNTS RECEVIABLE

The Company reports accounts receivable at estimated net realizable amounts generated for products delivered and services rendered from federal and state managed health care plans, commercial insurance companies and patients.  Collections of these accounts receivable are the Company’s primary source of cash and are critical to the Company’s operating performance.  The Company estimates uncollectible patient accounts primarily based upon its experience in historical collections from individual patients.  Bad debt expense is reported within Other operating expenses within the Consolidated Statement of Income and Comprehensive Income.  At June 30, 2014 and December 31, 2013, net accounts receivable included the allowance for doubtful accounts of $11.3 million and $10.0 million respectively.

NOTE D — GOODWILL AND OTHER INTANGIBLE ASSETS

The Company completes its annual goodwill and indefinite lived intangible impairment analysis in the fourth quarter of each year. The Company has the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step quantitative goodwill impairment test.  If the Company determines that a two-step goodwill impairment test is necessary or more efficient than a qualitative approach, it will measure the fair value of the Company’s reporting units using a combination of income, market and cost approaches.  No triggering events have transpired since October 1, 2013.

Goodwill allocated to the Company’s operating segments for the six months ended June 30, 2014 and for the year ended 2013 are as follows:

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The balances related to intangible assets as of June 30, 2014 and December 31, 2013 are as follows:

Customer lists are amortized over their estimated period of benefit, generally 10 to 14 years.  The majority of value associated to trade names is identified as an indefinite lived intangible asset, which is assessed for impairment on an annual basis. Trade names not identified as an indefinite lived intangible asset are amortized over their estimated period of benefit of approximately 1 to 5 years.  Patents are amortized using the straight-line method over 5 years.  Total intangible amortization expenses were $3.8 million and $3.3 million for the six months ended June 30, 2014 and June 30, 2013, respectively.  The weighted average life of the additions to customer lists, patents and other intangibles is 10 years.

NOTE E — INVENTORIES

Patient Care—Inventories at Hanger Clinic, Dosteon and Cares, which consists of raw materials, work-in-process and finished goods, amounted to $122.3 million and $109.2 million at June 30, 2014 and December 31, 2013, respectively. Inventories in Hanger’s Clinics, which amounted to $111.9 million and $99.0 million at June 30, 2014 and December 31, 2013, respectively, consist principally of raw materials and work-in-process inventory valued based on the gross profit method, which approximates lower of cost or market using the first-in first-out method. Inventories in the Dosteon business amounted to $9.2 million and $8.9 million at June 30, 2014 and December 31, 2013, respectively, and consisted principally of raw materials. As of June 30, 2014, the Dosteon inventories were valued based on the gross profit method, which approximates lower of cost or market using the first-in first-out method. Inventories in the Cares business amounted to $1.2 million and $1.3 million as of June 30, 2014 and December 31, 2013, respectively, consisted principally of finished goods and are valued at the lower of cost or market using the first-in first-out method based on perpetual records.

Hanger Clinic and Dosteon do not maintain a perpetual inventory system. On October 31st of each year the company performs an annual physical inventory of all inventories in Hanger Clinics. Dosteon counted its inventories on December 31, 2013 and October 31, 2012. The Company values the raw materials and work-in-process inventory counted at October 31 at lower of cost or market using the first-in first-out method. Hanger Clinic work-in-process inventory consists of materials, labor and overhead which is valued based on established standards for the stage of completion of each custom order. Material, labor and overhead costs are determined at the individual clinic or groups of clinics level. Adjustments to reconcile the Hanger Clinic and Dosteon physical inventory are treated as changes in accounting estimates and are recorded in the fourth quarter.  In the fourth quarter of 2013 the Company recorded a decrease to inventory of $2.3 million based on this reconciliation.

For Hanger Clinics, the October 31st inventory is subsequently adjusted at each quarterly and annual reporting period end by applying the gross profit method. As it relates to materials, the Company generally applies the gross profit method to individual clinics or groups of clinics for material costs. Labor and overhead and other aspects of the gross profit method are completed on a Hanger Clinic-wide basis. A similar approach is applied to Dosteon inventory, as applicable.

Products & Services—Inventories consisted principally of finished goods, which are stated at the lower of cost or market using the first-in, first-out method for all reporting periods and are valued based on perpetual records.

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Inventories as of June 30, 2014 and December 31, 2013 are as follows:

NOTE F — PROPERTY PLANT & EQUIPMENT

Property, plant and equipment are recorded at cost less accumulated depreciation, with the exception of assets acquired through acquisitions, which are initially recorded at fair value. Equipment acquired under capital leases is recorded at the lower of fair market value or the present value of the future minimum lease payments. The cost and related accumulated depreciation of assets sold, retired or otherwise disposed of are removed from the respective accounts, and any resulting gains or losses are included in the Consolidated Statements of Income and Comprehensive Income.

During the second quarter of 2014, the Company re-evaluated its policy regarding the maximum economic useful life of key software systems.  Due to the anticipated life of such systems, historical usage of similar assets, and the significant investment that would be required to replace the software which would make it unlikely for the Company to quickly replace, the Company determined such software could have an economic useful life of up to 10 years.  Historically, the Company’s policy provided for a maximum economic useful life for computer and software equipment of 5 years.  As of June 30, 2014, no software with an estimated useful life of greater than 5 years has been placed into service nor has the economic useful of any software previously placed into service been changed.

Depreciation is computed for financial reporting purposes using the straight-line method over the estimated useful lives of the related assets, which is generally as follows:

Capital Lease Obligations

Included within the Buildings line item were $21.9 million and $10.9 million of buildings recorded under capital leases, as of June 30, 2014 and December 31, 2013, respectively.  Accumulated depreciation on these capital leases were $1.8 million and $0.9 million, as of June 30, 2014 and December 31, 2013, respectively.  The annual future minimum lease payments as of June 30, 2014 under the lease agreements are $1.5 million, $3.0 million, $3.1 million, $3.2 million, $3.2 million, $17.3 million for the years ending December 31, 2014, 2015, 2016, 2017, 2018 and thereafter.  These future minimum lease payments include $10.2 million of interest.

Long-Lived Asset Impairment

The Company evaluates the carrying value of long-lived assets to be held and used whenever events or changes in circumstance indicate that the carrying amount may not be recoverable. The carrying value of a long-lived asset group is not recoverable and is considered impaired if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. The Company measures impairment as the amount by which the carrying value exceeds the fair market value. Fair market value is determined primarily using the projected future cash flows discounted at a rate commensurate with the risk involved. Losses on long-lived assets to be disposed of are generally determined in a similar manner, except that fair market values are reduced for the cost to dispose. There were no long-lived asset impairments or indicators of impairment for the periods ended June 30, 2014 and December 31, 2013.

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NOTE G — ACQUISITIONS

During the six months ended June 30, 2014, the Company acquired nine companies, operating a total of 32 patient care clinics. The aggregate purchase price for these O&P businesses was $47.6 million. Of this aggregate purchase price, $12.9 million consisted of promissory notes, $0.6 million was made up of contingent consideration payable within the next two years and $34.2 million was paid in cash. The excess of purchase price over the aggregate fair value was recorded as goodwill. The Company preliminarily allocated the purchase price to the individual assets acquired and liabilities assumed, consisting of $4.4 million accounts receivable, $3.0 million inventory, $34.1 million of goodwill, $7.6 million of definite lived intangibles, $1.5 million of indefinite lived intangibles, fixed assets and other assets of $6.5 million and accounts payable and other liabilities of $9.3 million. The Company’s valuations are subject to adjustment as additional information is obtained; however these adjustments are not expected to be material.  The value of the goodwill from these acquisitions can be attributed to a number of business factors including, but not limited to expected revenue and cash flow growth in future years. Contingent consideration is reported as other liabilities on the Company’s Consolidated Balance Sheet. The Company elected to treat all of these acquisitions as asset acquisitions for tax purposes resulting in all of the Q2 recorded goodwill as being amortizable for tax purposes. The expenses incurred related to these acquisitions were insignificant and were included in Other operating expenses on the Company’s Consolidated Statements of Income and Comprehensive Income.

During the six months ended June 30, 2013, the Company acquired two O&P companies, operating a total of nine patient care clinics. The aggregate purchase price for these O&P businesses was $6.9 million. Of this aggregate purchase price, $0.3 million consisted of promissory notes, $1.8 million is made up of contingent consideration payable within the next two years and $4.8 million was paid in cash. The Company recorded approximately $2.7 million of goodwill related to these acquisitions, and the expenses incurred related to these acquisitions were insignificant and were included in Other operating expenses.

The results of operations for these acquisitions are included in the Company’s results of operations from the date of acquisition. Pro forma results would not be materially different. In connection with contingent consideration agreements, the Company made payments of $0.6 million and $0.9 million in the first six months of 2014 and 2013, respectively. As of June 30, 2014 the Company has accrued a total of $2.4 million related to contingent consideration provisions related to acquisitions made in prior periods.

NOTE H — LONG TERM DEBT

Long-term debt consists of the following:

Refinancing

During the second quarter of 2013 the Company refinanced its bank credit facilities through a new 5 year Credit Agreement that increased its senior secured facilities to an aggregate principal amount of up to $425.0 million from $400.0 million previously.  The new Credit Agreement includes a $200.0 million revolving credit facility and a $225.0 million term loan facility. Each new facility matures on June 17, 2018 and is subject to a leveraged-based pricing grid, with initial pricing of LIBOR plus 1.75%.  In conjunction with the refinancing, the Company incurred a pre-tax non-cash charge of approximately $6.6 million during the second quarter of 2013 related to the write-off of existing debt issuance costs associated with its previous credit agreement.  No prepayment penalties were incurred.

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Revolving Credit Facility

The $200.0 million Revolving Credit Facility matures on June 17, 2018 and bears interest at LIBOR plus 1.75%, or the applicable rate (as defined in the Credit Agreement).  As of June 30, 2014, the Company had $106.4 million available under this facility. The outstanding amounts borrowed under the Revolving Credit Facility as of June 30, 2014 were $90 million, including standby letters of credit of approximately $3.6 million. The obligations under the Revolving Credit Facility are senior obligations, are guaranteed by the Company’s subsidiaries, and are secured by a first priority perfected security interest in all of the Company’s assets, all the assets of the Company’s subsidiaries and the equity interests of the Company’s subsidiaries.

The carrying values of the Company’s outstanding Revolving Credit Facilities as of June 30, 2014 and December 31, 2013, were $90.0 million and $25.0 million, respectively.  The Company has determined the carrying value on these loans approximates fair value for debt with similar terms and remaining maturities based on interest rates currently available and has therefore concluded these are Level 2 measurements.

Term Loan Facility

The Term Loan Facility, of which $219.4 million is outstanding, matures on June 17, 2018 and bears interest at LIBOR plus 1.75%, or the applicable rate (as defined in the Credit Agreement).  Quarterly principal payments ranging from 0.625% to 3.75% of the initial principal borrowed are required throughout the life of the Term Loan.  From time to time, mandatory prepayments may be required as a result of certain additional debt incurrences, certain asset sales, or other events as defined in the Credit Agreement. No mandatory prepayments have been required under our Term Loan Agreement to date. The obligations under the Term Loan Facility are senior obligations, are guaranteed by the Company’s subsidiaries, and are secured by a first priority perfected security interest in all of the Company’s assets, all the assets of the Company’s subsidiaries and the equity interests of the Company’s subsidiaries.

The carrying values of the Company’s outstanding Term Loans as of June 30, 2014 and December 31, 2013, were $219.4 million and $222.2 million, respectively. The Company has determined the carrying value on these loans approximates fair value for debt with similar terms and remaining maturities based on interest rates currently available and has therefore concluded these are Level 2 measurements.

71/8% Senior Notes

The 7 1/8 % Senior Notes mature November 15, 2018, senior indebtedness, and are guaranteed on a senior unsecured basis by all of the Company’s subsidiaries. Interest is payable semi-annually on May 15 and November 15 of each year.

Prior to November 15, 2014, the Company may redeem all or some of the notes at a redemption price of 103.6% of outstanding principal amount plus and amount equal to the unaccrued interest that would otherwise have become due from the redemption date through November 15, 2014.  On or after November 15, 2014, the Company may redeem all or a part of the notes with a premium, as described in further detail in the Company’s Annual Report on form 10-K for the year ended December 31, 2013.

The carrying value of the Senior Notes was $200.0 million as of June 30, 2014 and December 31, 2013.  The fair value of the Senior Notes was $210.0 million and $213.3 million as of June 30, 2014 and December 31, 2013, respectively.  The Company has determined the fair value of the Senior Notes based on market observable inputs and has therefore concluded these are Level 2 measurements.

Seller Notes

Seller Notes are recorded at contractual carrying values of $30.5 million and $21.1 million as of June 30, 2014 and December 31, 2013, respectively, and carrying value approximates fair value for similar debt in all material respects.  The Company estimates fair value of the seller notes with a discounted cash flow model using unobservable rates and has determined these represent Level 3 measurements.

Subsidiary Guarantees

The Revolving and Term Loan Facilities and the 7 1/8 % Senior Notes are guaranteed by all of the Company’s subsidiaries. Separate condensed consolidating information is not included because Hanger, Inc., the parent company, does not have independent assets or operations. The guarantees are full and unconditional and joint and several. There are no restrictions on the ability of the Company’s subsidiaries to transfer cash to the Company or to co-guarantors.

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Debt Covenants

The terms of the Senior Notes, the Revolving Credit Facility, and the Term Loan Facility limit the Company’s ability to, among other things, purchase capital assets, incur additional indebtedness, create liens, pay dividends on or redeem capital stock, make certain investments, make restricted payments, make certain dispositions of assets, engage in transactions with affiliates, engage in certain business activities, and engage in mergers, consolidations and certain sales of assets. The Credit Agreement requires compliance with various covenants including but not limited to (i) minimum consolidated interest coverage ratio of 3.50:1.00 and (ii) maximum total leverage ratio of 4.00:1.00. As of June 30, 2014, the Company was in compliance with all covenants under these debt agreements.

NOTE I — COMMITMENTS AND CONTINGENT LIABILITIES

Contingencies

The Company is subject to legal proceedings and claims which arise from time to time in the ordinary course of its business, including additional contingent payments under business purchase agreements.  In the opinion of management, the amount of ultimate liability, if any, with respect to these actions, will not have a materially adverse effect on the financial position, liquidity or results of operations of the Company.

The Company is in a highly regulated industry and receives regulatory agency inquiries from time to time in the ordinary course of its business, including inquiries relating to the Company’s billing activities. To date these inquiries have not resulted in material liabilities, but no assurance can be given that future regulatory agencies’ inquiries will be consistent with the results to date or that any discrepancies identified during a regulatory review will not have a material adverse effect on the Company’s consolidated financial statements.

Guarantees and Indemnifications

In the ordinary course of its business, the Company may enter into service agreements with service providers in which it agrees to indemnify or limit the service provider against certain losses and liabilities arising from the service provider’s performance of the agreement. The Company has reviewed its existing contracts containing indemnification or clauses of guarantees and does not believe that its potential liability under such agreements is material to the Company’s financial position.

Purchase Agreements

Effective April 2, 2014 the Company entered into a 5 year purchase commitment with $3.0 million of minimum future commitments outstanding as of June 30, 2014.

NOTE J — REVENUE RECOGNITION

Revenues in the Company’s Patient Care segment are derived from the sale of O&P devices and products and the maintenance and repair of existing devices. Revenues from maintenance and repairs are recognized when the service is provided. Revenues from the sale of devices and products are recorded when the patient has accepted and received the device or product and are recorded net of known and estimated future contractual adjustments and discounts. Contractual adjustments and discounts are recorded as contra-revenue within net sales on the Consolidated Statement of Income and Comprehensive Income. Medicare and Medicaid regulations and the various agreements we have with other third-party payors under which these contractual adjustments and discounts are calculated are complex and are subject to interpretation. Therefore, the devices and related services authorized and provided, and the related reimbursement, are subject to interpretation and adjustment that could result in payments that differ from our estimates. Additionally, updated regulations and pay schedules, and contract renegotiations, occur frequently, necessitating regular review and assessment of the estimation process by management.

Reserves for future contractual adjustments are estimated utilizing historical trends for such adjustments and are monitored monthly. As of June 30, 2014 and December 31, 2013, the Company estimated the reserve for future contractual adjustments and discounts to be $27.7 million and $20.6 million, respectively. The increase in the estimate is primarily related to revenue growth resulting from both same clinic sales growth and clinic acquisitions, and changes in reimbursement trends. Individual patients are generally responsible for deductible and/or co-payments. The reserve for future contractual adjustments and discounts is reflected as a reduction of accounts receivable on the Company’s Consolidated Balance Sheet.

Revenues in the Company’s Products & Services segment are derived from the distribution of O&P devices and the leasing of rehabilitation technology combined with clinical therapy programs, education and training. Distribution revenues are recorded upon the shipment of products, in accordance with the terms of the invoice, net of estimated returns. Discounted sales are recorded at net realizable value. Leasing revenues are recognized based upon the contractual terms of the agreements, which contain negotiated pricing and service levels with terms ranging from one to five years, and are generally billed to the Company’s customers monthly.

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NOTE K — NET INCOME PER COMMON SHARE

Basic per common share amounts are computed using the weighted average number of common shares outstanding during the year. Diluted per common share amounts are computed using the weighted average number of common shares outstanding during the year and dilutive potential common shares. Dilutive potential common shares consist of stock options and restricted shares and are calculated using the treasury stock method. Anti-dilutive shares are insignificant and do not impact the income per share calculation for the three and six months ended June 30, 2014 and 2013, respectively.

NOTE L — SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN (SERP)

The Company’s unfunded noncontributory defined benefit plan (the “Plan”) covers certain senior executives, is administered by the Company and calls for annual payments upon retirement based on years of service and final average salary. Benefit costs and liability balances are calculated based on certain assumptions including benefits earned, discount rates, interest costs, mortality rates and other factors. Actual results that differ from the assumptions are accumulated and amortized over future periods, affecting the recorded obligation and expense in future periods.

The following assumptions were used in the calculation of the net benefit cost and obligation at June 30, 2014 and 2013 is as follows:

The Company believes the assumptions used are appropriate; however, changes in assumptions or differences in actual experience may affect our benefit obligation and future expenses. The change in the Plan’s net benefit obligation for the six months ended June 30, 2014 and 2013:

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NOTE M - STOCK-BASED COMPENSATION

On May 13, 2010, the shareholders of the Company approved the 2010 Omnibus Incentive Plan (the “2010 Plan”) and suspended future grants under the Amended and Restated 2002 Stock Incentive and Bonus Plan (the “2002 Plan”) and the 2003 Non-Employee Directors’ Stock Incentive Plan (the “2003 Plan”). No new awards have been granted under the 2002 Plan or the 2003 Plan since that date; however, awards granted under either the 2002 Plan or the 2003 Plan that were outstanding on May 13, 2010 remain outstanding and continue to be subject to all of the terms and conditions of the 2002 Plan or the 2003 Plan, as applicable.

The 2010 Plan provides that 2.5 million shares of Common Stock are reserved for issuance, subject to adjustment as set forth in the 2010 Plan; provided, however, that only 1.5 million shares may be issued pursuant to the exercise of incentive stock options. Of these 2.5 million shares, 2.0 million are shares that are newly authorized for issuance under the 2010 Plan and 0.5 million are unissued shares not subject to awards that have been carried over from the shares previously authorized for issuance under the terms of the 2002 Plan and the 2003 Plan. Unless earlier terminated by the Board of Directors, the 2010 Plan will remain in effect until the earlier of (i) the date that is ten years from the date the plan is approved by the Company’s shareholders, which is ten years from the effective date for the 2010 plan, namely May 13, 2020, or (ii) the date all shares reserved for issuance have been issued.

As of June 30, 2014, of the 2.5 million shares of common stock authorized for issuance under the Company’s 2010 Plan, approximately 1.9 million shares have been issued, 0.3 million shares have been cancelled and 0.9 million shares are available for issue. During the first six months of 2014, the Company issued approximately 0.3 million shares of restricted stock units under the 2010 Plan. The total fair value of these grants is $11.0 million. Total unrecognized share-based compensation cost related to unvested restricted stock units was approximately $22.9 million as of June 30, 2014 and is expected to be expensed as compensation expense over approximately four years as the units vest.

For the six months ended June 30, 2014 and 2013, the Company has included approximately $5.3 million and $4.1 million, respectively, for share-based compensation cost in the accompanying condensed consolidated statements of income for the 2010 Plan. Compensation expense relates to restricted stock unit grants under that plan.

NOTE N — SEGMENT AND RELATED INFORMATION

During the first quarter of 2013, the Company assessed and updated their operating segments to align with how the business is managed and determined their reportable segments are the same as their operating segments.  The Company has identified two operating segments and both performance evaluation and resource allocation decisions are determined based on each operating segment’s income from operations.  The operating segments are described further below:

Patient Care —This segment consists of (i) the Company’s owned and operated patient care clinics and (ii) its contracting and network management business.  The patient care clinics provide services to design and fit O&P devices to patients. These clinics also instruct patients in the use, care and maintenance of the devices. The principal reimbursement sources for the Company’s services are:

·                  Commercial and other, which consist of individuals, rehabilitation providers, private insurance companies, HMOs, PPOs, hospitals, vocational rehabilitation, workers’ compensation programs and similar sources;

·                  Medicare, a federally funded health insurance program providing health insurance coverage for persons aged 65 or older and certain disabled persons, which provides reimbursement for O&P products and services based on prices set forth in published fee schedules with 10 regional pricing areas for prosthetics & orthotics and by state for DME;

·                  Medicaid, a health insurance program jointly funded by federal and state governments providing health insurance coverage for certain persons in financial need, regardless of age, which may supplement Medicare benefits for financially needy persons aged 65 or older; and

·                  U.S. Department of Veterans Affairs.

The Company estimates that government reimbursement, composed of Medicare, Medicaid and the U.S. Department of Veterans Affairs, in the aggregate, accounted for approximately 40.7% and 40.6%, of the Company’s net sales for the six months ended June 30, 2014 and 2013, respectively.

The Company’s contract and network management business is the only network management company dedicated solely to serving the O&P market and is focused on managing the O&P services of national and regional insurance companies. It partners with healthcare insurance companies by securing a national or regional contract either as a preferred provider or to manage their O&P network of providers. The network now includes approximately 1,170 O&P provider locations, including over 400 independent providers. As of June 30, 2014, the Company had 58 contracts with national and regional providers.

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Products & Services—This segment consists of the Company’s distribution business, which distributes and fabricates O&P products and components for both the O&P industry and the Company’s own patient care clinics, and its rehabilitation solutions business. The rehabilitation solutions business leases rehabilitation equipment and provides evidence-based clinical programs to post-acute rehabilitation service providers. This segment also develops emerging neuromuscular technologies for the O&P and rehabilitation markets.

Other — This consists of corporate overhead and includes unallocated expense such as personnel costs, professional fees and corporate office expenses.

The accounting policies of the segments are the same as the Company’s accounting policies which are located in the audited consolidated financial statements included in the Company’s Form 10-K for the year ended December 31, 2013 filed with the SEC.

Summarized financial information concerning the Company’s operating segments is shown in the following table. Intersegment sales mainly include sales of O&P components from the Products & Services segment to the Patient Care segment and were made at prices that approximate market values.

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